It’s much more than money. A leading expert on behavioral finance shares lessons from his latest book, What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions.
At a dinner party some years ago, a fellow guest, an engineer who had learned that I am a professor of finance, wanted to know where he could buy Japanese yen.
“Why do you want to buy Japanese yen?” I asked.
“Because its value is sure to zoom past the American dollar,” he said. He proceeded to list the American budget deficit, its trade deficit, and other indicators of the advantage of the Japanese yen over the American dollar.
I wanted to tell my fellow guest quickly and gently that, while his thinking is quite normal, it is not very smart.
“Buying and selling Japanese yen, American stocks, French bonds, and all other investments,” I said, “is not like playing tennis against a practice wall, where you can watch the ball hit the wall and place yourself at just the right spot to hit it back when it bounces. It is like playing tennis against an opponent you’ve never met before. Are you faster than your opponent? Will your opponent fool you by pretending to hit the ball to the left side, only to hit it to the right? Think for a moment,” I said to my fellow guest. “You are on one side of the net, thinking that the yen will go up. Your opponent is on the other side, thinking that it will go down. One of you must be the slow one. Have you considered the possibility that the yen seller might be Goldman Sachs, Barclays, Bank of Tokyo-Mitsubishi UFJ, or another of many traders in the yen market who have offices in both Tokyo and New York and know more about both the Japanese and American economies than you can learn from your morning’s Wall Street Journal?”
“The sum of our wants and behaviors makes financial markets go up or down as we herd together or go our separate ways.”
Yet there is more to investing and tennis than faulty thinking. My fellow guest wanted to make money on his yen trade, but he also wanted to feel the thrill of winning when the yen zooms. He wanted to express himself as a player in financial markets, not one who stands at the market’s sideline. And he wanted to be a member of the investing community, the community of people who observe financial markets, trade in them, and share their experiences with one another.
We are intelligent people, neither irrational nor insane. We are “normal smart” at times and “normal stupid” at other times. We do our best to increase the ratio of smart behavior to stupid behavior, but we do not have computers for brains, and we want benefits computers cannot comprehend.
We want high returns from our investments, but we want much more. We want to nurture hope for riches and banish fear of poverty. We want to be number one and beat the market. We want to feel pride when our investments bring gains and avoid the regret that comes with losses. We want the status and esteem of hedge funds, the warm glow and virtue of socially responsible funds, and the patriotism of investing in our own country. We want good advice from financial advisors, magazines, and the Internet. We want to be free from government regulations yet be protected by regulators. We want to leave a legacy for our children when we are gone. And we want to leave nothing for the tax man. The sum of our wants and behaviors makes financial markets go up or down as we herd together or go our separate ways, sometimes inflating bubbles and at other times popping them.
Utilitarian, expressive, and emotional
The benefits of a job come in packages, and we face trade-offs as we choose among them. A lawyer who wants to earn money but is also passionate about public advocacy can choose a public advocacy package with little money and much passion or a corporate law package with more money but less passion. Investments are like jobs, and their benefits extend beyond money. Investments express parts of our identity, whether that of a trader, a gold accumulator, or a fan of hedge funds. Investments are a game to many of us, like tennis. We may not admit it, and we may not even know it, but our actions show that we are willing to pay money for the investment game. This is money we pay in trading commissions, mutual fund fees, and software that promises to tell us where the stock market is headed. And investments are about what we would do with the money we make and how it makes us feel. Investments are about a sense of security in retirement, the hope of riches, joy and pride of raising our children, and paying for the college education of our grandchildren.
Investments, jobs, products, and services have benefits that enhance wealth, well-being, or both. These include utilitarian benefits, expressive benefits, and emotional benefits. Utilitarian benefits are the answer to the question, What does it do for me and my pocketbook? The utilitarian benefits of watches include time telling; the utilitarian benefits of restaurants include nutritious calories; and the utilitarian benefits of investments are mostly wealth, enhanced by high investment returns.
Expressive benefits convey to us and to others our values, tastes, and status. They answer the question, What does it say about me to others and to me? A stock picker says, “I am smart, able to pick winning stocks.” A Goldman Sachs client says, “My status is high enough to be selected to invest $2 million or more in Facebook shares.”
Emotional benefits are the answer to the question, How does it make me feel? Insurance policies make us feel safe, lottery tickets give us hope, and an offer to be among the first to own Facebook shares makes us proud.
What we want ... and what we should
We are not embarrassed to admit that we want our investments to support us during our years in retirement. Neither are we embarrassed to admit that we want our investments to support our children or favorite charities. But some of what we want from our investments is embarrassing, such as our wanting status. We might want to mention our investments in hedge funds, knowing that hedge funds signal high status because they are available only to the wealthy. But a loud expression of status, like a loud display of an oversize logo on a Gucci bag, can bring embarrassment rather than an acknowledgment of status.
Wants are also difficult to acknowledge because they often conflict with shoulds. The voice of wants says, “I want this new red sports car,” but the voice of shoulds says, “You should buy a used sedan and add the difference in price to your retirement account.” Investment advice is full of shoulds: Save more, spend less, diversify, buy-and-hold. Wants are visceral while shoulds are reasoned. Wants emphasize the expressive and emotional benefits of investments while shoulds emphasize the utilitarian ones. Wants often drive us into stupid investment choices, while shoulds drive us mostly into smart ones.
What should we ask, as individuals and society?
The first question I ask myself, as an individual, is, What do I want from my investments? The second is, How can I get what I want? You might wish to ask the same questions. Do you want enough money for a secure retirement, help for your children, and perhaps a contribution to Santa Clara University? Do you enjoy tinkering with your mutual funds as others enjoy tinkering with vintage cars? Do you care about the status conveyed by your hedge funds as others care about the status conveyed by luxury cars? Trade-offs are common in investments as in all of life, and most wants are reasonable if pursued in moderation. Heavy trading of investments is more likely to shrink your portfolio than expand it, but light trading might add to your enjoyment more than it detracts from your comfort in retirement. Yet it is foolish to trade retirement comfort for a vain hope for investment profits higher than their risks. Remember that there is an idiot in every trade. Are you really sure that you are not that idiot?
The question I ask myself as a member of society is, Should government regulations lean toward libertarianism, freeing us to invest as we wish, or should government regulation tilt toward paternalism, constraining choices to protect us from ourselves and from others? Should government protect home buyers from the cognitive errors and emotions that lead them to sign mortgage documents before they have read them because the stack of documents is too high and the emotional pull of homeownership is too strong? And should the government protect us, the neighbors of foolish and emotional homeowners, from the consequences of their likely defaults and foreclosures? Changes in regulations over time reveal our continuing attempts, through the legislative process, to find the right balance in the tug-of-war between those who pull toward the libertarian end and those who pull toward the paternalistic end.
That tug-of-war goes on because we cannot agree on the perfect balance between them. The awkward balance between them is reflected in a government that provides both Social Security and lotteries. The first is paternalistic, forcing us to save when we are young, and saving us from poverty when we are old. The second is libertarian, giving adults the freedom to spend as much as they want for hope at riches.
Investments are about life beyond money, and that we should enjoy all the benefits of investments—utilitarian, expressive, and emotional. We can enjoy these benefits ourselves, indulging in a few luxuries, or we might enjoy them with family, friends, and people in our neighborhoods and faraway continents. But, in the end, we cannot take our investments with us.